Russia launched its Phase 2 of its military campaign in Ukraine in April, when it withdrew from northern Ukraine to concentrate its forces on taking Donbas. Now it has launched its Phase 2 of its economic war against Europe by stopping the gas flows through Nord Stream 1 completely in response to the G7 threat to impose an oil price cap scheme.

The NS1 shutdown is a significant scaling up of Russia’s use of its economic weapons. At the end of last week gas prices were falling after EU members rolled out various relief packages, but they spiked this morning to $2,600 after the Dutch TTF spot market opened.

Gazprom’s announcement came after the G7 finance ministers said they were going ahead with the oil price cap scheme that is designed to cut the Kremlin off from its oil export tax revenues, but Russia has already said that it will simply stop exporting to anyone that attempts to implement the scheme.

Basically it's now a game of chicken: the West is banking on the hope that Russia will need the money and so continue to export oil even at reduced prices; and Russia is banking on the hope that if it cuts off European oil exports that will cause a global shortage and send oil prices into the stratosphere, thus massive exacerbating the energy crisis that is already tearing into European economies. Plus Russia seems pretty confident that the oil price cap scheme can’t be made to work because of all the leakages. Who can take the most pain? At this point my money is on Russian President Vladimir Putin, as Russians do pain like no one else. Poignantly there were two protests this weekend in Prague and Cologne against the rising cost of living and in the UK the eye-wateringly high cost of living is getting a full court press treatment by the press. Life on the street in Moscow remains pretty normal, while SMEs in the UK are getting £20,000 power bills where they used to pay £2,000 a year.

I think the protests will grow. Albania, one of the poorest countries in Europe, was amongst the first to cross the “we can’t afford this” line in April with protests. Now it has spread to Europe’s heartland. Of course both the Czech and German protests were by pro-Russia supporters and one assumes that the Kremlin had a hand in these protests, but clearly mainstream Europe is now at the “we can’t afford this” line too and it will only get worse.

One aspect of this whole story that is underreported is just how expensive this war is proving to be. German Chancellor Olaf Scholz announced a new €65bn relief package on Saturday – double the total amount of two previous packages – and Italy’s economic minister also said Rome has already spent €54bn and that will reach €100bn by the end of this year. The total cost to Europe so far is on the order of €300bn but that will clearly hit half a trillion by Christmas and maybe €1 trillion by the end of the heating season. The UK is almost certainly in recession and Robin Brooks of Institute of International Finance (IIF) says it is now inevitable the rest of Europe will follow soon – except Hungary that just bought even more cheap gas from Russia and also has an exemption from the coming oil import ban that goes into effect in December.

Another factor that people are not factoring in is that the focus is on this winter’s gas crisis. With the tanks over 80% full if the winter is not too cold then Europe can probably squeak through this year, albeit at extraordinary cost. But in April the process of refilling the tanks will begin, but without NS1 at all. That can’t be done. The alternative supplies from Azerbaijan, Algeria and Norway are all marginal, and the really big new LNG project in Qatar doesn’t come online until 2025 at the earliest (and only then if the EU agrees to sign up to long-term contracts, which it doesn’t want to do), so there will be another even bigger gas crisis next year that will cost at least another €1 trillion and condemn Europe to another year of recession.

European governments have yet to put themselves on a war footing and prepare their populations for two years of hardship. Scholz's new relief package is symptomatic of the general approach so far: throw money at the crisis to try to keep life as usual going, but the question is if Europe can afford it and how committed is the EU population to actually suffer for the sake of Ukraine? Call me cynical, but I don’t think they are committed enough to wreck their own economies for the sake of a country that is a member of neither Nato nor the EU.

 

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